Social Capital: Six Startup Strategies to Upend Incumbents

In 2015, thousands of taxi drivers in Paris rioted blocking thoroughfares, damaging cars, and threatening Uber drivers while seeking a ban of Uber in France. Local authorities responded by jailing Uber’s general manager in France.

The riots in Paris were a patent response among local taxi drivers who felt threatened by Uber and sought relief from local governments. Shortly after its founding in 2009, Uber received its first cease-and-desist notice from San Francisco imposing a $5000 fine per ride and 90 days in jail for each day Uber remained in operation. Uber has defended its right to operate in cities worldwide ever since.

Uber, like other ride hailing startups, initially complied with local ordinances. The CEO of Taxi Magic explained its decision to work within the system: “We bet the regulatory environment would hold … Almost every city had police that enforced the taxi laws.” But local governments neutered the benefits of ride hailing by regulating both pricing and driver permits to level the playing field with taxi drivers. Ultimately, Uber bet on a more disruptive approach. It let the market decide by discounting fares and expanding its service to meet customer demand.?? ?

Taxi drivers who had invested as much as $1.2 million in some cities for a coveted permit were understandably upset. City councils considered bans on Uber in Washington DC in 2012 and New York in 2015. But Uber appealed directly to its local customers. Within one day, DC city councilmembers received 50,000 emails and 37,000 Tweets with hashtag #UberDCLove. More than 200,000 customers in New York City signed a petition to drop proposed restrictions. Both cities backed down allowing ride hailing, though local efforts to limit Uber continue.

The visceral opposition by taxi drivers to ride hailing reflects a broader pattern of incumbent response to startup innovation. Paris recently banned e-scooters amidst lobbying efforts by the same taxi drivers who countered Uber. San Franciso and New York City threatened to ban AirBnB after hotel operators lobbied to prevent short-term rentals. The Chinese government banned Facebook, Twitter and Google a decade ago citing privacy concerns in favor of TenCent and Baidu. The U.S. has recently threatened to ban TikTok citing similar privacy concerns.

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Social Capital: The Network Architecture of Markets

Financial capital, human capital and political capital are valued currencies among entrepreneurs. Founders need funding, talent and, often, a clear regulatory runway to launch startups.

Social capital is less recognized yet increasingly important for startup success in a digital world. Social capital in a business context is the network of relationships that enable companies and markets to function well.[1] Social capital includes reputation and branding, yet also describes a firm’s position within the network architecture of an industry. Social capital complements financial, human and political capital. Human capital is what you know; social capital is who you know. Like human capital, social capital is a durable asset but must be maintained and nurtured to remain relevant.[2]

Social capital evolves as industries mature. At market inception, social capital is non-existent beyond the founders’ personal networks. As markets develop, firms build stakeholder networks consisting of customers, suppliers, partners, employees and service providers. These independent company networks converge as an industry matures. A network architecture for the industry emerges and becomes denser as the web of customer, supplier and partnership relationships expands. Industry leaders coalesce the network architecture around them as an industry consolidates enabling incumbents to solidify their social capital as an industry matures.

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Social Capital and the Competitive Dynamics of Startups v. Industry Incumbents

Competitive dynamics vary across industries, yet incumbents typically enjoy several advantages. They nurture longstanding customer and supplier relationships and often have access to more financial resources. Corporate executives benefit from industry expertise and networks built over decades of industry experience. Incumbents often leverage political capital to influence regulation, a process known as ‘regulatory capture.’[3] Figure 1 illustrates these four dimensions on which startups compete with incumbents.

Figure 1: Four Dimensions on which Startups compete with Incumbents ???

Startups can offset traditional incumbent advantages and level the playing field in industries undergoing significant technology change. Industry outsiders bring fresh perspectives that may not be apparent to insiders. The rise of data, cloud computing and artificial intelligence has upended many traditional industries offering new opportunities for startups. The growth of venture capital has enabled startups to compete directly with incumbents, an otherwise formidable task a couple decades ago.

Similarly, startups can tap several strategies to alter social capital to their advantage, especially for disruptive innovation. Before we discuss these strategies, it is useful to understand how social capital adjusts to incremental and disruptive innovation.

Social capital remains intact with incremental innovation, which accepts established industry structure and builds social capital through market expansion. The semiconductor industry has grown as new generations of cheaper, more powerful chips enable new electronic devices to serve a broader array of customers. Over the past fifty years, the semiconductor industry has expanded with Moore’s Law from advanced military technology to 17 billion devices and sensors, or 2.1 per capita, today. ??

Disruptive innovation fundamentally alters social capital dynamics in an industry. Disruptive innovation rearchitects market networks upending the balance of power in an industry. For example, ride hailing not only expanded the taxi market by more than four times in cities but also coalesced and converted a community of customers into ride hailing advocates to offset incumbent political clout with cities. ?

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Five Ways Startups Can Leverage Social Capital to Outflank Incumbents

Startup success is highly correlated with its social capital.[4] Social networks showcase firm performance for better or worse. Indicators of customer satisfaction or disappointment are a click away. Glassdoor offers a window into employee assessments of its executives. These online indicators can create virtuous cycles or vicious circles in a firm’s efforts to attract customers, funding and talent.

Following are six ways that entrepreneurs and startups can leverage social capital to outflank incumbents and achieve market leadership.

1.?????? Identifying Startup Opportunities: ?Entrepreneurial networks expand the range from which they can source startup ideas. Startups flourish in vibrant ecosystems where entrepreneurial networks spawn new ideas through “knowledge spillovers.” Communities of practice share complex information and tacit knowledge vital to innovation.[5] Diverse networks are important as creative ideas tend to emerge from industry outsiders. In my study of recent unicorn IPOs, 62% of entrepreneurs who founded disruptive startups had no prior industry experience, while 85% of founders promoting incremental innovation came from within the industry. Entrepreneurs with diverse networks can tap varied perspectives that help detect and develop good ideas[6].

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2.?????? Devising New Business Models to Bridge Gaps in the Market: Innovation often emerges at the edges bridging two adjacent fields. Ride hailing initially competed with limos then expanded beyond taxis. AirBnB combined elements of hotels and homestays. Micromobility fills a gap between public transport and taxis. By filling holes in two adjacent markets, entrepreneurs can rearchitect industry networks[7] rendering old networks obsolete as we observed with Uber in ride hailing. Much like technical debt, traditional industry networks seem antiquated when startups rearchitect industry networks by spanning adjacent markets or attracting new groups of users.

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3.?????? Leveraging Weak Ties to Attract Stakeholders: Referral networks help attract investors, customers and partners. People from the same community tend to have redundant networks that confer little added value beyond one’s personal network. Surprisingly, the majority of professional jobs come ?through weak ties.[8]? Savvy entrepreneurs similarly leverage the “strength of weak ties” through extended networks who confer trust among potential investors, customers and partners that they could not otherwise directly access. Savvy entrepreneurs give small gifts that signal respect and ignite a spirit of reciprocity that benefits both parties. In the past three decades, I have made several investments through referrals to entrepreneurs by trusted advisors that have emerged through shared interests. ???

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4.?????? Rapid Prototyping to Achieve Product Market Fit: Lean startups leverage rapid prototyping to engage customers with a minimum viable product and iterate quickly based on user feedback and reach product market fit faster and inexpensively. Begun in the 1970s, rapid prototyping has grown with online collaboration that enhances and streamlines user feedback. Crowdsourcing and open-source software accelerate rapid prototyping by enabling developers and users to engage directly in product and software development. In its early days, Lime[9] did weekly A/B testing on its mobile app and monthly iterations on its scooters to increase vehicle utilization and durability. Feedback from its most active users rapidly improved product design enabling Lime to scale quickly and be the first in the industry to reach profitability. While rapid prototyping techniques are available to all companies, nimble startups are best equipped to iterate quickly on user input. ????

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5.?????? Accelerating Adoption with Product Led Growth: Barriers to adoption are higher for unfamiliar products or services. Startups target early adopters and referenceable customers to gain initial traction but still must cross the chasm for broader adoption. Social networks open new ways for startups to accelerate growth while reducing marketing costs. Startups enlist early adopters and thought leaders as “social proof” heralding the benefits of their offerings. Product led growth strategies offer easy to use products with freemium pricing that allow users to try it before they buy it. Startups spur viral growth by creating a herd mentality and fear of missing out (FOMO) as products move toward mass adoption. These combined strategies help rewrite the network architecture of an industry in favor of the startup vis-à-vis incumbents.? ????

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6.?????? Building Platforms Through Open Innovation: Incumbents often prefer closed networks as they reinforce desired behavior and confer proprietary advantage to those within the network.[10] But social networks are permeable making closed networks hard to maintain. The most valuable global tech companies today are digital platforms, many of which promote open innovation. Digital platforms provide a common software infrastructure layer for software developers and ecosystem partners, which reduces development costs, enables a common interface for data aggregation, and promotes a standardized, scalable solution serving a shared market objective. Digital platforms enjoy significant network effects, which offset traditional incumbent advantages.

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Social capital is the glue that builds loyalty among customers, employees, suppliers and investors. Social capital complements financial, human and political capital and is increasingly important for startup success in a digital world. Social capital builds a firm’s brand and reputation. Startups can use social capital to remake the network architecture of an industry and compete with incumbents on neutral footing. The six strategies outlined above can be effective early steps in leveraging social capital to accelerate growth and balance inherent incumbent advantages.

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[1] This business definition aligns with the broader definition of social capital from the Oxford Dictionary: "the networks of relationships among people who live and work in a particular society, enabling that society to function effectively".

[2] For more background on social capital, see Adler, P., Kwon, S. (2002). Social Capital: Prospects for a New Concept.

[3] George Stigler won the Nobel price in Economics for his work on regulatory capture.?

[4] A review of 59 studies found that social capital positively influences startup success, especially in the high-tech industry. See Stam et al (2014).

[5] See Wenger, E. (1998). Communities?of?Practice:?Learning?as a?Social System for a detailed account of how communities of practice work as a catalyst for innovation.

[6] See Burt, R.S. (2004). Structural Holes and Good Ideas. See also Landry, R., Amara, N., & Lamari, M. (2002) for a case study in Montreal.

[7] See Burt (2014). Structural Holes: The Social Structure of Competition.

[8] See Granovetter (1973). The Strength of Weak Ties.

[9] Disclosure: NGP Capital is an investor in Lime.

[10] Walker, G., Kogut, B., & Shan, W. (1997) make the case for the benefits of closed networks rather than open networks. Chesbrough, H. (2003). Open Innovation: The New Imperative for Creating and Profiting from Technology is an early and widely followed advocate of open innovation.